david@taxpage.com

416 367 8649

Dividend Types under the Canadian Income Tax Act

Dividend Types under the Canadian Income Tax Act – A Toronto Tax Lawyer Analysis

Introduction - Dividend Types under the Canadian Income Tax Act

The most common type of dividend of which one might be aware is the standard cash dividend – a payment of cash from a corporation to its shareholders. However, a dividend does not have to be in the form of cash and can take the form of any type of value transfer from a corporation to its shareholders if it is declared as a dividend by the directors of the corporation. These non cash dividends are called dividends in kind and for example, a dividend may be in the form of additional stock, specific property, or notes payable. Additionally, regardless of the form the dividend takes, a dividend can be either an eligible or non-eligible dividend, which essentially affects the tax rate the individual will pay on those dividends. Finally, where a corporation has realized capital gains, life insurance policy proceeds, or capital dividends from another corporation, a type of non-taxable dividend, called a capital dividend, can be issued.

Eligible Dividends vs. Non-Eligible Dividends

An important concept in Canadian tax law is the idea of tax integration. In a general sense, integration is the idea that the ultimate income tax rate of a particular stream of income once it reaches the hands of the individual should be approximately the same tax rate regardless of how he decides to organize his affairs. More concretely, that means the total income tax on a particular stream of income will be the same regardless of whether it was earned directly by an individual, or earned in a corporation and then paid out to that individual as a salary or as a dividend. Where an individual earns income directly, the tax will simply be at the individual’s marginal tax rate and where a corporation earns the income and pays it to the individual as a salary, the corporation can deduct the salary as an expense, and thus pays no tax on that amount, and the individual again pays at his personal marginal rate.

However, dividends (except for dividends from the Capital Dividend Account) are paid from a corporation’s after tax profits, meaning that the corporation would have already paid corporate income tax on that income. So, if the individual then paid his full marginal tax rate on the dividend he receives, that stream of income would have been subjected to both the corporate tax as well as individual tax and thus have been subjected to double taxation. In order to achieve tax integration, the Canadian income tax system employs a dividend gross-up and a dividend tax credit mechanism which essentially results in the individual paying a lower amount of tax on a dividend he receives in order to account for the tax that the corporation has already paid.

This is complicated by the fact that corporations in Canada pay different tax rates depending on whether they qualify for the small business deduction or manufacturing and processing deduction, and so the dividend gross-up and dividend tax credit have to be adjusted to account for the particular tax rate of the dividend issuing corporation. As such, corporations that do not qualify for the small business deduction would have paid the higher corporate tax rate and thus, the dividends that they declare can be subject to more favourable tax treatment to the individuals receiving the dividend, subject to some conditions discussed below, and are referred to as eligible dividends.
On the other hand, dividends issued by Canadian Controlled Private Corporations (CCPCs) that receive the small business deduction are referred to as non-eligible dividends and individuals who receive these dividends are subject to less favourable tax treatment than individuals receiving eligible dividends. One caveat is that a CCPC might hold shares of a non-CCPC and receive eligible dividends from that non-CCPC, so those amounts are tracked in a special account called the General Rate Income Pool, or GRIP, and the CCPC can then pay out eligible dividends to its shareholders up to the amount of GRIP that it has.

On the flip side, a non-CCPC can also have shares and receive ineligible dividends from a CCPC – those amounts are tracked in another special account called the Low-Rate Income Pool, or LRIP, and the non-CCPC is restricted from issuing any eligible dividends while it has a positive LRIP balance. In order to reduce its LRIP balance, a non-CCPC must pay out ineligible dividends and once the LRIP balance is eliminated, then the non-CCPC may once again issue eligible dividends. While the details of how this is all calculated is complicated, the gist of it is that CCPCs pay a reduced rate of tax relative to non-CCPCs on the active business income that they earn. But when their profits are distributed to their shareholders as non-eligible dividends, the shareholders pay personal income tax on those dividends at a rate higher than for eligible dividends, but lower than if it was a salary. However the aggregate total tax paid by the corporation and the individual who receives the dividend is approximately the same as seen by the chart below for an individual paying tax at the top marginal tax rate in Ontario. Call our top Toronto tax law firm to learn more about the tax treatment of dividends.

Corporate Tax Rate

Personal Tax Rate

Combined Tax Rate

Eligible Dividends

25%

39.34%

54.5%

Non-Eligible Dividends

15%

45.30%

53.5%

Employment Income

0%

53.53%

53.53%

Forms of Dividends

Additionally, the form of a dividend can vary widely. A dividend in its most basic form is simply a transfer of value from a corporation to its shareholders pursuant to a dividend declaration from the directors of the corporation. This transfer may be in the form of cash, but may also be a dividend in kind in the form of stock, property, or notes payable. A stock dividend is an issuance by a corporation of its stock to its shareholders. For stock dividends, the value of the dividend is calculated by the fair market value of the stock. For example, if an individual is issued a dividend of 1000 common shares of the corporation which are each worth a fair market value of $50, then the individual would have received a dividend worth $50,000 and the ultimate tax liability stemming from that dividend would depend on whether it was eligible or non-eligible as well as the individual’s marginal tax rate. A property dividend is a non-cash dividend, which technically includes stock dividends, but is more typically used to refer to distributions of equipment, inventory, or real estate, but also things like artwork or jewellery. For the individual, the value of the dividend is similarly calculated as the fair market value, but for the corporation, the distribution of property will be a disposition and thus trigger a taxable event. As such, the corporation will realize a gain or loss on the disposed property calculated as the current fair market value of the property minus the corporation’s adjusted cost basis in the property. Where a loss is being realized, this may prove to be an advantage to the corporation if the corporation is highly profitable, as the loss can be used to offset the corporation’s other gains or income. Dividends may even come in the form of notes payable which is a promise by the corporation to pay the shareholder at a later date – a type of debt. The note payable may accrue interest or not depending on the particulars, but this type of dividend can be useful in various types of corporate planning and corporate reorganizations. However, it is important to keep in mind that the note payable is considered income to the individual who receives it and that individual must include the value of the note payable in his Canadian income tax return for that year.

Capital Dividends

Regardless of the type of corporation or the form of the dividend, corporations can issue tax-free capital dividends so long as they have a sufficient capital dividend account balance. The capital dividend account stems from capital gains realized by the corporation as well as other non-taxable amounts earned by the corporation such as the proceeds from life insurance and capital dividends issued to the corporation from another corporation. Under Canadian Income Tax law, only half of a capital gain is taxable, while the other half is non-taxable and this applies to both corporations and individuals. As such, for capital gains, corporations only pay tax on the taxable half of the capital gain. However, as discussed earlier, the tax integration considers the combined taxation of a particular stream of income both when it is earned in a corporation and when it is later flowed out into individual taxpayers. Thus, the non-taxable half of the capital gain should still be non-taxable when it is flowed out to the corporation’s shareholders. This is achieved by recording the non-taxable portion in the corporation’s capital dividend account and allowing the corporation to issue non-taxable capital dividends to its shareholders.

Tax Tip – Dividend Types

While tax integration generally achieves its goal of taxing income equally regardless of how it reaches an individual, that does not mean there is no room for tax planning and optimization. Corporations pay lower tax rates than individuals and can be a great way to defer taxes on active income. Furthermore, careful planning as to how and when to issue dividends can ultimately reduce the amount of tax an individual pays. Our experienced Toronto tax lawyers can help business owners structure their business and their compensation to reach the best tax results – speak to one of our top Canadian tax lawyers and learn how we can help.

Published by: Jamin Chen

Disclaimer:

"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."

Free Income Tax Advice on Phone

We offer a free 10 minute income tax consultation with one of our students. We will identify your tax
problem and advise you if you need assistance from a tax lawyer to solve it and if so we will suggest a
one hour consultation with one of our lawyers, the fees if you wish to consult and a rough estimate of
the legal fees if you choose to retain us.

Schedule a Consultation

Resources

What Our Clients are Saying?

When I received a Notice of Assessment from the Canada Revenue Agency saying I owed an additional $99.769.24 in taxes, I was shocked and I had no idea where to turn. After searching on the internet, I quickly found the top ranked tax law firm of Rotfleisch and Samulovitch P.C. David Rotfleisch, CPA, J.D. listened to me explain my situation, and quickly filed a Notice of Objection on my behalf. They were successful in eliminating the extra amount CRA claimed I owed, and they even got rid of the interest and late filing penalties. My tax liabilities went from $99,769.24 all the way down to $4,040. I love that my case was handled quickly and in a way designed to keep costs low, and I could not be happier to recommend the firm to anyone with tax issues.

I.I., Toronto - Client

David J. Rotfleisch, CPA, JD was my tax and business lawyer in a difficult share sale transaction. He advised me on the income tax and business aspects, handled long and difficult negotiations and successfully closed the share sale. He was very “hands-on” with the deal and was able to resolve matters to my entire satisfaction. I recommend him for any business or tax matters.

Michael Bargman, Toronto, Tel Aviv - Client

David J. Rotfleisch, CPA, JD, represented me in the Tax Court of Canada and in the Federal Court of Appeal . My income tax case went back to the 1980s but was only heard in 2008 and 2009 partially due to the complexity. It involved securities hedging and complex business, complex law and complex accounting issues. I was fortunate to find a lawyer who even understood the business aspect. The organization of David’s firm enabled this successful case to be completed in a cost effective manner, which I doubt the larger law firms could have achieved. I am delighted with his representation and would recommend him without hesitation.

Russ Witt, Toronto - Client

I first met David Rotfleisch when he acted for the vendor of a business I bought, Richards-Wilcox, over 20 years ago. My partner and I were so impressed by him that once the deal was complete we retained him as our tax and business lawyer. He has acted for us on all tax and corporate matters since then, including the sale of our successful garage door business to Raynor in the US and has represented Raynor on the Canadian aspects of various transborder transactions. If you need a tax or business lawyer, David has a broad grasp of tax and business law and is helpful and responsive.

Ray Friesen Raynor Canada, Mississauga - Client

I am a serial entrepreneur, having been involved in different businesses over the years. David J. Rotfleisch has been my tax and business lawyer for over 20 years. He has helped me with complex income tax and GST/HST issues over the years, including tax prosecutions and a subsequent voluntary disclosure that was successfully submitted. I find him to be very experienced and knowledgeable and able to explain complex issues in very clear language. He has a passion for solving business and tax problems, not accepting CRA excesses and attacking CRA's abuses. David's professionalism , attention to detail and unrelenting persuit of justice for the"little guy" has given me comfort while the CRA wolves were pacing at the door.

E.P., Mississauga, Ont - Client

I own Multimedia Lighting & Electric Ltd, an electrical contractor that specializes in large display signs. David Rotfleisch has been my tax and business lawyer and advisor since I started in business more than 15 years ago. He is great at planning to reduce my taxes and keeping me out of any trouble with CRA. His planning and advice is clever and to the point and I rely on him without hesitation.

I first met David Rotfleisch when he acted for the vendor of a business I bought, Richards-Wilcox, over 20 years ago. My partner and I were so impressed by him that once the deal was complete we retained him as our tax and business lawyer. He has acted for us on all tax and corporate matters since then, including the sale of our successful garage door business to Raynor in the US and has represented Raynor on the Canadian aspects of various transborder transactions. If you need a tax or business lawyer, David has a broad grasp of tax and business law and is helpful and responsive.

Ray Friesen Raynor Canada, Mississauga - Client

I own Hometown Electric, an electrical contractor that specializes in large display signs. David Rotfleisch has been my tax and business lawyer and advisor since I started in business more than 15 years ago. He is great at planning to reduce my taxes and keeping me out of any trouble with CRA. His planning and advice is clever and to the point and I rely on him without hesitation.

Doug Hishon, Jr. Hometown Electric, Toronto, Ont - Client

I have used David Rotfleisch as my business and tax lawyer for over 20 years. I own and publish Canadian Homes & Cottages Magazine, and David has been our go to lawyer for over 20 years. He has handled all of my business and personal tax issues as well as my will and estate planning. David and his team are very good at anticipating and handling issues before they develop into problems, and in solving unexpected problems. I would not think of going to any other lawyer.

Dealing with adversarial tax issues is much like a root canal ,a painful but essential process to save the tooth. A skilled and confident Dentist is essential to the exercise.

David Rotfleisch and his staff provided me with a concise and timely roadmap through the Voluntary Disclosure Process. There are many people touting their connections and expertise in the media. David and his staff produce results in an understated and professional manner. Choose your advisor carefully and make it Rotfliesch & Samulovitch.

Dennis, Aurora, Ontario - Client

What Other Professionals are Saying?

I run a professional CPA practice with staff in Toronto, Canada and Texas, USA and have been dealing with David Rotfleisch's tax law firm for over 15 years. David and I have worked on many different CRA and business files over the years, including voluntary disclosures, audits and appeals and the purchase and sale of businesses. He provides practical and timely tax and business advice. I refer all of my clients who need a Canadian business or tax lawyer to David.

I am a chartered professional accountant and a partner with the national accounting firm of Collins Barrow. I have worked with David Rotfleisch on hundreds of client files over the last 15 years. He is my most accessible tax lawyer and the one that I frequently go to, especially since he also has an accounting degree. He understands the accounting side of the issues as well as the tax and business law considerations. He deals with tax problems in a direct and cost effective way. I strongly recommend him to anyone in need of a Canadian tax lawyer.

I am a long time professional bookkeeper.Â From time to time my clients need a Canadian tax or business lawyer for will or tax planning or have problems with CRA and have to file a Notice of Objection or Appeal to Tax Court, or have unfiled income tax returns and have to submit a Voluntary Disclosure.Â I have been working exclusively with David Rotfleisch's tax law firm for over 5 years.Â He and his staff are knowledgeable in tax and corporate matters, responsive,Â effective and provide cost effective tax solutions.Â I continue to refer clients to him and would recommend him to anyone who has need of his services.

Gail Carver, Bookkeeping in the Beach, Toronto, Ontario - Bookkeeper

As a tax CPA/CA I am always working with Canadian income tax lawyers to implement transactions or reorganizations, to provide income tax opinions for private or public deals and to carry out income tax litigation. I have been working with David Rotfleisch and his tax law firm for over 15 years. He has assisted me and my clients on all aspects of tax law. I enjoy working with him, he responds to phone calls and emails as soon as they are sent, he promptly reviews and comments on documents. I have only good things to say about him and do not hesitate to refer him to my clients.

As a Partner at Sloan Partners LLP, Chartered Professional Accountants I am heavily involved in tax planning and tax compliance matters for a diverse client base.
To assist us in providing the best service to our clients, we use lawyers to help formalize and implement income tax planning arrangements. In those cases where
our clients are challenged by CRA, we need a lawyer skilled in tax litigation to defend their positions. My relationship with David J. Rotfleisch goes back almost 20 years.
David has always been available to discuss concepts and issues and to provide invaluable assistance to clients. Although clients always come first, we also enjoy chatting
about photography since we’re both serious about that too.

We are a Toronto tax law firm with a Canada wide full service income tax law practice. We provide comprehensive income tax planning including individual will and estate planning and estate freezes as well as tax representation from the tax audit stage through to full income tax litigation including rectification applications and tax fraud assistance.